Business Negotiation

Once it becomes evident that there is an opportunity for a business deal, the buyer and seller of a business need to come together and negotiate the details of that deal. Negotiation is the process where the different parties work out a mutually beneficial agreement regarding the businesses value and conditions of the share ownership change. The study of negotiation draws on ideas from game theory (for the theoretical outcome between purely logical negotiators) and psychology (for the emotional and human angle). Game theory often assumes perfect knowledge of all mitigating factors that could affect the deal. Unfortunately, in business negotiations at least some of that knowledge is unattainable (or even suppressed) or interpreted differently by the negotiating parties. Also, the effects of emotions (especially negative ones) on negotiations distract from the logic of game theory. These two factors form the greatest unknowns in predicting the outcome of a negotiation.

The intentions of the negotiating parties generally guide the ethos of the negotiation and its progress. If all parties are intent on finding a mutually beneficial arrangement and are willing to make concessions, the negotiation will generally lead to innovative and collaborative solutions to problems that could derail the deal. If one of the parties intends to “beat” the other, the spirit of the negotiation will be much more competitive and confrontational and is likely to leave all participants feeling battered. The adage: “it’s not a fair deal until both parties are willing to give up on it” comes from this confrontational approach. Both approaches are used during business negotiations depending on the strength of the respective negotiators’ positions and the likelihood that the negotiators will work together after the deal is concluded.

Confrontational Negotiations

Confrontational business negotiations come about for several reasons:

  • One party is in a weaker negotiating position than the other (e.g. the business is not doing as well as it could or the buyer is short on funds).
  • The buyer is not likely to work with the seller after the deal is done (i.e. s/he is buying the entire business or buying the sellers share).
  • One party is naturally confrontational, suspicious or unwilling to yield. This means that the other party will need to apply similar tactics.

When negotiating for a business one generally needs to come to terms on the value of the business given its current state and its future prospects as well as any conditions attached to the business deal. Invariably, the negotiating parties will have different views on the value of the business based on the information and assumptions that they have about the business and its prospects. They will also have different intentions for the business deal. The seller will want to get the maximum value for the business while the buyer will want to negotiate the lowest price. These intentions mean that the negotiators will be naturally inclined to opposition which could in turn encourage one or both of them to use tactics that may trick or lead the other party astray (e.g. Withholding or obscuring information or low/high-ball offers). For negotiators with dubious ethics (especially on the sellers side) these types of negotiations become a balancing act between getting their way by their means and being able to deny culpability after the deal is done (when all information and tactics generally come to the fore). The level of polarisation between the competing intentions (and values) will determine whether a negotiated settlement can be reached and how hard it might be. Negotiations can also be influenced by a previous relationship between negotiators (if the buyer and seller have worked with each other before) or lack thereof (one is less worried about hurting the feelings of someone one is likely to not see again after the transaction is done) as well as the extent of the deal (e.g. buying a portion of a company means one needs to work together afterwards). A collaborative negotiation (see next paragraph) can descend into a confrontational one if one of the parties decides to play dirty later in the process. It is very unlikely to go the other way though.

Collaborative Negotiations

The alternative to confrontational negotiations are ones where both parties are attempting to find a solution where all parties win. The intention of the negotiation is to find a settlement where both parties walk away with a larger cake to share rather than a larger slice of the existing cake. To keep a negotiation in this realm requires:

  • Trust between the negotiators.
  • Good communication skills and controlled emotions in all parties.
  • Open and honest flow of information without ulterior motives or hindrances.
  • The ability to yield in all parties.
  • A belief that a common goal can be attained.

Negotiations in business have a tremendous scope to be win-win because there is no limit to how a deal could be structured. E.g. If a seller wants more money than the buyer has upfront he may be willing to yield on the payment terms. Similarly, a buyer may be willing to pay more if the seller continues for a few months to ensure a smoother ownership change and some training. As mentioned before, collaborative negotiations can descend to confrontational ones and are very unlikely to develop after having started in a confrontational manner.

The effect of emotions

Recent studies suggest that humans suffer from informational overload leading to decision apathy if they need to base their decisions on logic alone. Emotions help us make decisions quickly and they have been shown to be remarkably accurate. Thus emotions can never be removed from a decision to buy a business. That however refers to the emotions relating to the buying decision. The emotions aimed at the opposing negotiator can become a hindrance during the negotiation process (especially the negative ones). If a negotiator’s reactions are driven by emotions, they can eventually lose out in the negotiation because their emotions will betray them or they can be exploited. This is why it’s often recommended to have an emotionally non-involved proxy (such as a business brokers – see “Business Brokers – What’s their purpose anyway?”) during negotiations even with the extra layer of complexity this invariably adds.

Some Best Practices

The “opposing” negotiator

  • Make sure they’re the right person to negotiate with.
  • Get to know and form a rapport with them.
  • Empathise with them and walk a mile in their shoes.
  • Read their body language and emotions and tailor your responses to guide the relationship.
  • Build trust and do not react emotionally.

Get as much objective information as possible

  • Listen and ask questions without turning the negotiation into an interrogation.
  • Pay attention to the analysis of data and how it could be leveraged.
  • Read between the lines. Why might data is difficult to obtain or being withheld.

Be prepared

  • Pre-empt required information and get it ready.
  • Know how far you’ll allow someone to push the deal before you’re prepared to walk away. At very least know your value of the business given the available information.
  • Be open to- and bring new suggestions.

Presenting absolutes will stifle a creative solution

Business Valuation: A “How to” guide

Business valuation is a rather inexact science. Some aspect of it may even be referred to as an art, requiring imagination and forethought. But, even though it is a partially subjective field, business is hugely reliant on it as a starting point for a negotiation when any stake of it is up for an ownership change (either for sale, internal change or as options). Since businesses and business deals range vastly in size, scope and complexity there are many different ways to calculate and justify values for businesses. In this blog I will consider the principles behind some of these calculations and when one might apply them.
By definition, the value of a company is a price a willing buyer would be willing to pay to a willing seller for a company or share thereof. Since this price depends on the negotiated agreement between the buyer and seller it is a compromise between their respective views of the value a business has or can create. This means that the business may have different values to different buyers because of the influence they may have over its future potential. The smaller the influence a buyer has over a business’s potential (by virtue of the size of the stake they are buying or the decision making power they may have) and the more frequent a change of shares occurs, the more rigid and defined the price of the business.
Generally, businesses are bought- or invested in because investors want access to potential future income via one of the following routes:
• To finance a business with potential due to its innovative idea, good market and/or the credentials of involved parties.
• To save the time it would take (and avoid the risk) to build one up from the ground.
• To take over its customer base, intellectual property (including brands) and employees.
• To streamline or strengthen a business process by buying capacity or buying up competitors.
There are three general approaches to arriving at a value for a business. These are:
• Asset based valuations
• Market based valuations
• Income based valuations

Asset based Valuations

Asset based valuations set the value at the cumulative replacement value of the assets (excluding the amount still owed on them) the business requires for day to day running (at least) or those that are included in the sale. For most physical assets, finding a current replacement value is a relatively trivial exercise. Using depreciated values (from the company’s financials) would be extreme since accounting conventions generally allow assets to be written off much quicker than fair market value would, so adjustments need to be made when attempting to use this valuation from the financials (part of the process of “normalising” financials). To rely only on asset based valuations one would have to estimate the value of the intangible assets (such as brand or institutional knowledge) of a company. These are usually lumped into an “asset” value called “goodwill” and are largely subjective. A notable caveat to asset based valuations is that the buyer should have the right to sell the asset after the sale for the valuation to be meaningful. If they do not buy a controlling share this valuation may not be appropriate. Often, the current value of assets will be seen as the absolute minimum value a business should fetch.

Market based Valuations

Market based valuations rely on comparisons to the value of other businesses in the same market. Values are generally expressed as a “multiple” of sales or profit that is industry specific. This multiple is a factor that estimates (by means of averaging) market and business conditions and demand and supply (for businesses to be sold) in a particular industry. This immediately brings up the issues that no two businesses will ever be exactly comparable (perhaps excepting franchises) and that data for “multiples” needs to be extrapolated from available data. Getting multiples from listed companies is relatively easy (given their financials and stock price) but these generally need to be adjusted down for private companies due to the lack of liquidity (i.e. the demand for) in their shares. Data for private companies is also available from business brokers but this data is extrapolated from a small sample and is not reliably collected.

Income based Valuations

Income based valuations attempt to estimate the future income of a business. They then assume that the current value of the business is equal to an investment (at a specified level of risk) that would pay out a similar amount in the same time. That investment amount is the current value of the business. These methods require significant amounts of analysis of historical results and their associated market and business conditions. They then require assumptions of how the market will change in the future as well as the impact that this may have on a company. Other assumptions that have a major import on these analyses are:
• Interest and depreciation rates.
• Cost of capital (essentially the interest rates the company pays for its level of debt).
• The level of risk investment in the business exposes investors to (and the interest rate that would compensate for it).
• Future growth due to changes in the businesses structure or prospects.
Income based valuations are based on the most accurate models of the value a business can create (often calculated from normalised financials) but they inherently require many assumptions about the future and the level of risk for a company.

When do I use which business valuation method?

This leaves us with the question of when to apply which method of business valuation. Unfortunately there is no set answer for this. All evaluation methods have their merits and distractions and all give different answers to the ultimate value of a business. The valuation is thus dependent on the initiator of the valuation process. A business seller would want the highest possible value for their business. A business buyer would be aiming at the lowest possible value. Stock market investors look for a value that is higher than the current stock price while being justifiably representative of future movements.
The valuation also depends on the amount and type of available information and the size and status of the company in question.

Listed Companies

The most complex and large businesses are often the easiest to get a relatively accurate value for. If businesses are listed, the price of their shares multiplied by the number of shares in issue (the market capitalisation or MCAP) will determine the value of the company (at least the portion of it which is floated on the stock exchange). This estimate of a company’s value is a representation of the average values that many buyers (and investment funds) and sellers ascribe to it. Most funds will spend significant resources analysing companies based on their financial data and forecasts (many of which are useful for the valuation of smaller companies though probably too labour and information intensive). Other investors influence the share prices through the mass effects of their incremental beliefs of the value of the company (i.e. mass psychology). The end result is a value that generally only varies a little from day to day. Investors “bet” on the cumulative effects of these daily variations (day trading) or on perceived value, which they think the market will eventually recognise (value investing).
When larger stakes are bought in listed businesses, pinning down a value becomes more challenging. The sale of a larger stake will allow the buyer more influence over the company (and its future value) and thus, the price will be negotiated. Rumours of sale of a listed company or larger part thereof will generally cause the share price to move towards the negotiated price as increased or decreased investor demand (generally depending on what the company is being bought for – expansion or liquidation) drives valuations and mass psychology.
The valuation of listed companies is generally done via a combination of valuation methods, the emphasis on which one depending on the industry the company is in. Investment companies will value companies in industries that are relatively mature and highly competitive (where companies are not likely to change the way they earn a living and growth is generally determined by the growth of the market rather than innovation) by income based methods. In industries that are capital intensive (such as manufacturing or mining), asset based valuations might form the basis of an analysis with an income based portion based on assessments of future projects or contracts. They would generally use market based comparisons (e.g. Price/Earnings ratios) to compare companies and help to inform investment decisions only.
Less sophisticated investors (individual investors – no offence intended) might use market based valuations like P/E- (Price/Earnings) or other ratio comparisons or (so-called) “technical” analysis (essentially betting with a stock prices movement momentum or other historical trends).

Unlisted Companies

If the company which is up for sale is not listed there may be much less to go on as a starting point for a value. Previous share sales may not have happened or it may have been years prior to the current sales event and undoubtedly with the company at a different size and under different conditions. And even then, these previous sales may only be a tentative guideline and not representative of the value that a new buyer or investor might extract from a company. So where does one start?
The first question that needs to be asked is: At what stage of the business life cycle is the business? These stages are generally Start-up, Growth, Maturity and Decline followed up by either Rebirth or Death. Businesses in each of these stages have different properties which lend themselves to some valuation analyses better than others.

Start-up

Companies in this phase of the business life cycle generally have no historical financial data to analyse. These companies also generally don’t have much of an asset base to base a valuation on. At best, if they are going into a competitive market, they can be compared to similar companies but generally their evaluations are based on forecasts of the market, and assumptions about the business idea and the capabilities of the business team. Forecasts are generally conservative and impossible to quantify accurately. The assumptions are subjective, insecure and qualitative. Thus, investing in these businesses presents the highest level of risk which means that investors will demand high returns on their investment. Therefore the valuation of a business at this stage has less to do with the eventual value the business might create and more to do with the amount of money it may require in the near future (from the sellers side) and the risk appetite of the investor (from the buyer). As a consequence, the difference in value between a seller and a buyer is likely to be high.

Growth

In the growth phase the business concept of the company is proven and its focus is on expanding to fill the demand for its products. It will be in the process of increasing its asset base which might mean that it has taken on more debt. Asset based valuations would thus not be appropriate due to higher liabilities. Such companies will also be reinvesting any potential profits (or even make a loss) to finance the expansion. Thus some market based valuations (especially multiples of profits in relation to costs) would be disadvantageous. The only real option to value such companies is to use income based valuations. However, since the level and rate of growth is less predictable than in mature companies (see below) income based valuations for these companies rely on less predictable forecasts which exposes potential investors to higher risks but also higher potential profits than mature businesses (though not nearly as high as start-ups). The valuations of sellers and buyers are likely to be closer than for start-ups but not as close as for mature companies.

Mature

Mature companies rely on maintaining the status quo. The business model has been proven to work and they have carved out a market segment. The growth of the company is dictated by the organic growth of the market and gains in profitability can only be made by reducing costs. These companies are generally asset rich and a large proportion of the company value will be in the value of the assets. They will also have significant historical data that can be used to estimate future cash flows, costs and profits. Thus asset based valuations will determine the bulk of the value while income based valuations will become more consistent and predictable. Buyers of companies in this market segment are looking for a (virtually) risk free investment with predictable returns. They will thus pay a premium. Though valuations are becoming more predictable (also between sellers and buyers valuations), market based valuations are still dubious because of the data they will be based on. Comparative industry data for sales of privately held companies is unreliably collected and limited. It should be noted that most listed companies fall into this phase of the business life cycle.

Decline

By definition, companies in this part of the business life cycle are struggling and their valuation will depend on whether they will be followed by rebirth or death. If the company is moving towards death, its last remaining value will be in its assets. Since it will have little or no future income, income based valuations will be meaningless. If the company is moving towards rebirth, the principles of start-up or growth valuations would apply (see earlier) with consideration for existing asset value. Companies in this part of the life cycle generally offer the best value for a buyer since they can be valued for their assets (which could be sold to recoup that value) but have the upside of a potential turnaround.

Conclusion

Businesses are valued for a different of reasons. For investors, they are valued to see if they can be bought cheaper than they are currently trading. They are hoping to make relatively small returns while keeping risks to a minimum.
For sellers and buyers of private businesses, they are valued as a starting point in a negotiation. As such, the function of the value is to bring the right people and businesses together. The sellers starting value determines the depth of the pockets of the buyers he attracts. Whether they see similar value in the business will be determined during the negotiation (See “Business Negotiation”) and will ultimately determine the fate of the business sale.

Business Brokers – What’s their purpose anyway? Part 3: Do you need one?

In the previous two blogs I discussed the business brokers’ business model and the services they generally offer. In this blog I will discuss when one should consider using their services.

As mentioned in the first blog in the series, they should add value to the transaction. I.e. they should save the business owner time, aggravation and/or money over the course of the business sale process.

The question then becomes how much of the business sales process the business owner is prepared to- or capable of tackling on their own. I will investigate the sales process step by step as per the infographic in the “Process of Selling/Buying a Business” blog.

Preparation to Sell

Preparing a business for sale requires the finalisation of financials and any outstanding tax issues, collection of data one might require for the sale of a business (of which the financials are part) and getting the business in order so that it can command its highest price. To finalise the financials and deal with outstanding tax issues one will require accountants. To get the business in order should be an ongoing concern of any business owner. It should not just come up when the business is to be sold. If the business owner has an experimental nature, they will have tried to improve their bottom line constantly. If they are a little more settled or have been complacent about- or a little more distant (not being involved day-to-day) to the running of their business they may want to have a closer look at improving profits and cutting some of the dead weight in the business. Either way, myopia or “not seeing the woods for all the trees” may have set in and getting a second opinion on improvements that could be made could be invaluable. Suggestions could come from trusted advisors or business partners, management coaches or -consultants or very dedicated and highly trained or experienced business brokers that specialise in the businesses particular industry. Alternatively, the process of collecting the relevant data required for a business sale (see What you really want to know when investing in- or buying a business ) and improving the factors that go into a company valuation (see below) might highlight where the business should be focussing attention to increase sales or margins or where it could be reducing expenses or cutting dead wood.

Company Valuation

Company valuation is a rather tricky field because there is no correct, definitive value to a business. The only moment the value of a company is set is at the moment of sale of some of its shares when a willing buyer and a willing seller agree. Company valuations are based on some or all of the following factors:

  • Available information on the business (size, profits, assets, liabilities, sales figures, operations, organisational structure, human resources, branding/marketing, customer base, position etc.).
  • Comparative industry standards for price, saleability (demand) as well as past, current and future (forecast) market conditions.
  • Assumptions and models for future earnings of the company.

As such a valuation can become quite subjective. Business owners tend to believe that the value of their company is higher than it is because they price in the effort it cost them. Business buyers tend to believe that companies should be valued lower than the asking price because they need to price in uncertainty (and because they need this as a negotiating starting point). When business brokers are asked to get involved with valuations, they have to walk the line between offering the seller a price at which they will be happy and the buyer a price which is an enticing starting point for a negotiation. Unfortunately, businesses are not advertised with enough information to justify the valuation. The price thus just sets the price bracket the potential buyer is shopping in. Whether or not they will eventually see value in the business will only be ascertained during the negotiation and due diligence process. Business brokers can help by offering a valuation service (or recommending a valuation company) and by tempering the sellers’ expectations. They can however also convince the seller to drop their price in an effort to sell the business quickly to get their commission. The next blog will consider business valuation more closely.

Create Marketing Presentation

Marketing presentations should tell enough of the story to entice potential buyers to have a closer look but not so much that it puts the business at risk. As such they tend to be released in a two-staged approach. Initially, very limited information such as asking price, profit or free cash flow, location and type of business is used as the marketing profile. Once a potential buyer has committed to a non-disclosure agreement, more sensitive and substantial information can be supplied. The sort of information that is required for the in-depth portion of a marketing presentation can be found in my blog series about “Due Diligence Information”.

Most business brokers will help to create the “limited information” presentation. The level of information for the “in-depth” presentation varies may be considered beyond their scope because they feel that it gets too close to the potential conflict of interest of helping with the due-diligence (see below).

Advertisement

The level and approach to advertising a business for sale depends on the size of the business and who it is being marketed to. At their simplest level, businesses are sold to current employees and/or managers who have learnt the ropes and paid their dues in-house. This generally happens in consulting businesses like accountants- and law offices (with people making partner) where continuity of the client relationship with people inside the company is important.

If the business is in a very specific industry that requires specialised skills and knowledge to run (e.g. engineering consultancies or medical services), it is likely to be marketed on a one-to-one basis to potential buyers within professional networks. Though business brokers are in the business of networking broadly, they often don’t have the connections in specialised fields required. Often, these businesses are more likely candidates for mergers or acquisitions than sales to new owners.

The less specialised the knowledge required to run a business and the smaller it is, the more likely it is to be broadly advertised to the general public. Examples of these kinds of businesses are restaurants and convenience stores. Advertising used to be done in classifieds but have quickly moved to internet based advertising pages. These businesses are generally marketed with as little information as possible and require more stringent vetting of potential buyers (due to their broader advertising spread). Business brokers generally act in this section of the market though they may decide to specialise in particular markets (such as restaurant and entertainment or manufacturing businesses) and business sizes within this segment. Business brokers will generally market listings on their own websites and social networks (Facebook, LinkedIn) as well as “business for sale” style websites (which individual business owners also have access to). They will also root out “tire kickers” who are interested in business information but do not have the means or knowhow to complete the sale.

Qualify Buyers / Sellers

To make sure that the business deal has the best chance of happening, one needs to make sure that one doesn’t waste ones efforts on potential buyers (or businesses) that do not have the means or knowhow (or desired level of profit or potential) that are prerequisite. This requires credit checks (and/or checking assurances about funding) as well as a small personal interaction (at least). Business brokers guard against “tire-kickers” and people trying to glean information about the business for reasons other than sales interest but peoples intentions are generally fairly clear and easy to ascertain. Credit checks require varying levels of permission (depending on country) but there are generally online solutions to getting these done easily.

Non-Disclosure Agreement

Non-disclosure agreements attempt to secure the business sellers right to keep to business information out of public reach and (sometimes) to stop potential buyers from setting up competitive operations. They also generally act as the primary hurdle for business brokers to release more information towards potential buyers and thus protect the business broker from the seller should information leak (by giving the seller another party to hold liable). Generally non-disclosure agreements don’t seem to be a very effective way to legally stop information getting into the wrong hands since they are easily circumvented. They do, however, indicate a level of interest and intent from the buyer and will allow negotiations to be more open. Sample non-disclosure agreements can also easily be found online or obtained from lawyers. Most business brokers will insist on using their own non-disclosure agreement.

Negotiation

Negotiation is often referred to as an art and practiced negotiators often have an advantage at the negotiating table. Generally business owners get some experience at negotiating (with suppliers and clients) in the course of running their business but the stakes are somewhat higher when negotiating for the sale of the business. The outcomes of negotiations are generally affected by the amount and quality of information that gets shared and the emotional state of the negotiators. The more a party thinks with their heart rather than their head, the more likely they will be taken advantage of during a negotiation. Having an external party can mitigate the effect of emotions on the negotiation but increases the complexity in information flow (needing approval for what can and cannot be shared). At the end of the day, the information that the agreement is based on needs to be accurate and comprehensive. Should information that would affect the deal not be disclosed, it might form the basis for a breakdown of the deal (at best) or legal action. For more information on business negotiation, check out my blog on “Business Negotiation”.

Letter of Intent

The letter of intent is a legally non-binding document detailing the buyers’ intent to make an offer on a business. It is usually given during or after negotiations and states the details of the business deal and that it is contingent on a successful due diligence which is bound by the confidentiality agreement. Business brokers generally have samples of these letters on file but they can also be easily found online or obtained from lawyers.

Due Diligence

Business brokers who are hired by sellers generally don’t get involved with due diligence because there is a conflict of interest between the buyers’ and sellers’ intentions at this point. Buyers need to verify all the information that the negotiation and tentative agreement is based on before signing the final contract. Business brokers might be hired by buyers to aid in this process (especially if they already had them help out during the negotiation process) though accountants might be more suited for this role. Please check my blog series on “Due Diligence Information” for the sort of information that would be useful and easily verified.

Legal Agreement

Though legal agreements are available for download from the internet (which could be amended to fit the business deals particulars), both the buyer and seller of a business will want the peace of mind that comes with a lawyer having set up the paperwork. Business brokers will generally have a lawyer they can recommend. Some might have sample agreements on file (as case studies for different business deals) but most will be reluctant to take on the responsibility of having these amended and used without a lawyer.

Conclusion

So the question remains: Do you need a business broker? The answer is: It depends on the business you’re trying to sell, how fast you want to sell it and how much effort you are willing to put in yourself. None of the services offered by business brokers are so specialised that reasonably savvy and involved business owners could not learn to do them themselves in the time required to prepare and sell their business.

Some businesses are not suitable for sale with the help of business brokers. These are:

  • Businesses that are struggling.
  • Fledgling businesses that have not had enough time and resources to show a profit (i.e. businesses that are priced on their potential).
  • Businesses that are highly specialised or so big that they attract the attention of Merger and Acquisition groups.
  • Businesses that are so small that their sale will not compensate brokers adequately for their efforts.

Business Brokers – What’s their purpose anyway? Part 2: Business Brokers Services

The previous blog had a look at the business brokers’ business model. This blog will consider the services they actually offer. These services can be grouped under several headings:

Value enhancement and Valuation

There is no one “correct” way to establish a value for a business. The most accurate measure of a business’s value is the price at which a willing seller will sell to a willing buyer. For businesses that are listed, a value of a business can be ascertained because there are likely to be at least a few trades of a business’s shares on a regular basis (since there is a willing buyer and seller for a share in the business). Though this won’t be the fixed price when buying a large chunk of a business (these are generally done at a premium to the individual share price), the market capitalisation of a listed business is generally a good starting point of its value.

For businesses that are not listed, there will much fewer share interactions so this is not a viable method of valuation. At this point, valuations are generally an estimate of current replacement value of assets held in the businesses as well as/or an estimate of the future value it can create through sale of its products/services or the strategic advantage it might offer. There may also be an element of comparison to asking prices for similar businesses which are currently for sale. For more information on business valuation, check out my blog on “Business Valuation: A “How to” guide”.

Since valuation is partially subjective, enhancing that value through changes in a company (structure, product, service, operations, marketing, etc.) can have variable results though increasing profits is generally a good sign. Very committed business brokers, as part of their service, work with business owners to ensure that a business presents as well as possible when it comes to selling it. This may be a relatively long-term (18 months to 2 years prior to listing) commitment of business coaching and/or management consulting.

Most business brokers will offer a valuation service (either themselves or by affiliated specialist valuation companies). Note that business brokers walk a fine line between presenting business owners with a price that is high enough for their expectations for their business (which are often inflated due to years of blood, sweat and tears) and low enough to be market related and give the business a good chance to sell. Either way, the valuation is just a starting point for negotiations and buyers are going to present valuations to substantiate their point of view of the company (which are always going to be lower than or equal to the asking price). The negotiations will determine at what price (between the asking price and buyers valuation) the business will eventually sell if the sale goes through.

Note that, before a business can sell, its financials generally have to be in order and it needs to be in good standing with the taxman. Some business brokers will help with this though most generally represent businesses that aren’t likely to have these hurdles to overcome.

Marketing

To market a business to potential buyers, business brokers generally set up a marketing presentation. This presentation usually contains some general business information, a SWOT analysis and a reason to sell. It may also be quite a bit more comprehensive covering human resources, ownership structure, services and products, operations, assets and liabilities and more detailed financial information (essentially information gathering for due-diligence). To set up this presentation, business brokers will need to spend varying amounts of time (depending on the comprehensiveness of the presentation) in the business and with its financials. This presentation is shared with potential buyers (usually after a non-disclosure agreement is signed) but control over who gets to see this sensitive information should be at the forefront of the business brokers (and business owners) intentions. Vetting of potential buyers will be considered under the next heading.

Business brokers will have you believe that marketing a business for sale to the general public is fraught with danger. For bigger transactions, businesses are generally marketed directly to potential buyers or institutional investors. If not marketed directly, businesses are generally marketed anonymously out of fear that knowledge of its “for sale” status might affect current trading. It is assumed that this happens due to changes in relationships between owners, managers, employees, clients and suppliers and that a competitor may attempt to find out more about the running of the business or to jeopardise the sale. One should consider as well that business brokering is a rather cutthroat business and that some of them attempt to “steal” mandates by approaching business owners directly. Thus business brokers have a vested interest in keeping the business anonymous (or signing a “sole-mandate” agreement with business owners).

There is an advantage to having multiple potential buyers because sellers can play them of against each other during a negotiation. The likelihood of attracting several buyers depends on the saleability of the business and the effectiveness of its marketing. Note that, depending on the compensation structure, business brokers may have more interest in finding single potential buyers rather than multiple buyers for each business. Once a viable buyer is identified they may feel that their time is better spent focussing on their other listings.

The amount of data released and under which conditions (e.g. initial marketing, “non-disclosure” agreements in place or “letter of intent”) forms part of the dance during the negotiation process.

Negotiation

Before a negotiation can get under way, business brokers often vet buyers, ostensibly for their financial status and fit as owners of the business. Buying a business often requires a substantial financial investment (depending on the business deal the current business owner might be interested in). Note that it is in both the business owners’ and  business brokers’ best interest to find buyers who are most likely to complete the sale process and that a large section of responders to marketing attempts are likely to be “tire kickers”. Doing credit checks can be fairly routine nowadays though it generally requires consent. Business brokers who claim to have “hundreds of qualified buyers looking for businesses just like yours” often neglect to mention that these buyers are qualified only because they have subscribed to the brokers website or mailing list. This is a marketing ploy by some business brokers to attract new listings. If they had serious buyers their time would be better spent looking for businesses than waiting for them.

Negotiation is a fine art. It’s an interaction between two or more parties who have different expectations and agendas and it involves information (and its interpretation) and sometimes emotion. The hope is that a mutual agreement, that all parties can live with, can be reached but by negotiators natures, it can be quite adversarial.  Business brokers can either represent or advise the buyer or the seller during the negotiation. They often see themselves as a buffer between the buyer and seller in the hope of taking out some of the emotion that these parties might have invested in the company or the sales process. It should be noted though that they will never know the business as well as the business owner and that their interest will always slant towards the completion of the agreement first (so that they can get paid) and secondly towards the party who will eventually pay them. Often both buyers and sellers have business brokers to represent- or advise them during the negotiation. The value of a good negotiator cannot be underestimated but, once emotion is mitigated as a factor, the business information should be the guiding factor to reach an agreement. For information on the sort of information required please see my blogs on “Business Information” and “Due Diligence Information”. For more information on business negotiation, check out my blog on “Business Negotiation”.

Administrative

By virtue of dealing with many business sales, business brokers will have a good idea of all the administrative-, financial- and legal processes required as well as the local regulations that may pose stumbling blocks. They also have a vested interest in making sure that the process doesn’t stall or slow down since they generally only get paid once the deal is done. This means that they will keep up the pressure on both the buyer and the seller to complete the transaction. Given that the buyer and seller will generally have an interest in getting the deal expedited the business brokers’ knowledge and contacts might be useful.

A notable exception to the administrative services that the sellers’ business brokers generally offer seems to be help with the due diligence. This is the process where the buyer verifies the information that the negotiated agreement is based on. Business brokers usually cite a conflict of interest when it comes to this task and pass it on to (or suggest) accountants.

In the next blog I will consider when a business broker will add value to a business deal.

Business Brokers – What’s their purpose anyway? Part 1: The Business Brokers’ Business Model

The time has come to sell your business. This is a rather daunting undertaking with organisational-, financial-, legal- and social hurdles to overcome and it makes sense to look for help. Your first option might be an internet search on how to sell a business and you’re immediately bombarded with business brokers who claim to be able to sell it quickly and at the highest value. They have professional looking websites and promise lists of qualified buyers looking for businesses just like yours. But then you dig a little deeper and you start finding stories about business sellers who have been ripped off by unscrupulous business brokers who didn’t do much for the exorbitant commission they demanded. I’m hoping that this blog can help you to decide whether you need a business broker, and what they should be offering you if you decide to list with one.

As a business owner you’ll know that your decision on the use of a business broker should be based on sound financial reasoning. This means that hiring one should be based on at least one of these reasons:

  • They can save you time, effort and money during the selling process.
  • They can sell the business for more that you could on your own (in addition to their fees).

If neither of these conditions is met, they are making money at your expense. Unfortunately, it’s extremely hard to quantify the value they might add to your business (since you’ll never have a comparative offer) so I’ll focus on the functions they may help with and what the services they offer which should add value.

However, before I start with the services business brokers offer, it’s worth considering the business brokers’ business model.

The Business Brokers’ Business Model

It might be stating the obvious, but business brokers are in business to make money. This means that their efforts will naturally gravitate towards the markets where they can make the most profit for the amount of time they are willing to put in. For some business brokers this means focussing on a particular area and/or industry or specialising in businesses of a particular size. For others this might mean putting a smaller amount of effort into many more businesses to cast a wider net. Needless to say, more personal attention should be the order of the day from the business seller’s point of view. Increased marketability of a business, and thus increased opportunity to earn a commission, will determine the amount of effort a business broker will put into selling a business (or whether they will list it under their name). Thus, businesses offered by business brokers generally seem to be profitable, well run and established. Very few business brokers will help you to sell a business that is struggling or a fledgling. These businesses are more likely to be served by business incubators.

There are generally two ways in which business brokers charge. They can charge a commission on the sale of a business or they can charge a service fee based on the number of hours they have put into a particular function (such as valuing the business or creating a marketing brochure). The way they structure their billing should immediately indicate the level of service one might expect from them. If they want a large, upfront payment for services and no commission, they may be tempted to tail their service off once the billable work is done. If they charge only a commission, they may be tempted to advertise with little or no business preparation. A fixed commission might tempt them to try to sell more businesses at a lower price. The best compromise is generally a payment for upfront services followed by a “selling price” dependent (sliding scale) commission, sometimes with the upfront payment deferred or taken out of the commission on sale. Note that commissions seem to be anything between 3% and 15% depending on the size of the company, country and level of service offered by the broker. This should suggest that commissions can be negotiated between seller and broker.

Note that, in most countries, to charge a commission on the sale of businesses and the property tied up in them, business brokers need to be registered estate agents and that this is generally the only qualification they need. Due to this relatively low barrier to entry, there is very real scope for unscrupulous- or incompetent business brokers and in difficult current market conditions there has been grumbling about estate agents moving in on business brokers’ turf without the proper knowledge required to sell businesses. To mitigate this, there are regional and worldwide business brokers associations and it is certainly worth investigating if a potential broker is a member.

In the next blog I will consider the functions business brokers perform in the process of selling a business.

Business IQ vs. EQ: Conclusion

Businesses grow. They generally start out as simple ideas. They are then mixed with energy, optimism, a little funding and a lot of scrambling to make the idea feasible or to conform it to the needs of the market enough to produce a consistent income. As they grow and change, experience about what works and what doesn’t is gained by those involved in shaping the businesses. They also make assumptions as to the reasons for successes and failures but generally, very little of this gets documented for posterity.  At best there will be financials (and the paperwork that goes into producing them), a few evolving policy documents and ad campaigns, and some bills for costly mistakes (school-of-hard-knocks fees) to remind business owners what they’ve been through and what they’ve learnt along the way. A lot of the factors that will influence a business’s success or failure might not even be recordable. How would one write up the character traits of key employees or managers or the flow that a team can create?

As businesses grow larger, some of the systems that make them function well become ingrained. They form part of the company culture and the “way things were always done” (though, if this is too rigid it may cause problems down the line). If the business is big enough to have separate managerial functions, it will tend to start documenting results by way of minutes of meetings, managerial reports and management accounts. These form an invaluable source of data and could be analysed to glean some of the institutional information that makes a company tick. Smaller (and family) businesses tend to keep going for years based on the experience and gut-feel of individuals in the management structure. Note that this way of running a business seems to be no less successful than running it based on the hard numbers analysed in minutia and both can mitigate and cause their fair share of stresses (fear of the unknown or fear of the known respectively). It will, however, cause problems when the time comes to pass the business on to someone else.

Unless they worked in the companies structure, when a new person takes over (for whatever reason), they will struggle with the nuances required to keep operations smooth. They are generally motivated to make sweeping changes and improvements anyway (why else take over a business). For this reason a “hand-over” time, where the previous owner shows the new owner the ropes, is often stipulated in a business sales agreement.

In the end, the business owner needs to be comfortable with the level of information that they produce and analyse to run a business. For some, this may be full management accounts and psychometric profiles. For others this may be come down to the firmness of a handshake and a good feeling about their decisions. Both approaches have their advantages and disadvantages and both can lead to success and failure. Most business owners and managers will fall somewhere on the spectrum between those two extremes. As long as they know that, at some stage in the life cycle of the business, someone will want to see the nitty-gritty numbers

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